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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
---------------------
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended:
March 31, 2004
Commission File Number: 1-13086
FNB FINANCIAL SERVICES CORPORATION
(Exact name of Registrant as specified in its Charter)
North Carolina 56-1382275
(State of Incorporation) (I.R.S. Employer Identification No.)
202 South Main Street
Reidsville, North Carolina 27320
(Address of principal executive offices) (Zip Code)
(336) 342-3346
(Registrant's telephone number, including area code)
---------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |X| No |_|
At May 3, 2004, 5,501,605 shares of the registrant's common stock, $1.00
par value, were outstanding.
This Form 10-Q has 22 pages. The Exhibit Index begins on page 17.
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FNB FINANCIAL SERVICES CORPORATION
FORM 10-Q
INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets
March 31, 2004 and December 31, 2003 3
Consolidated Statements of Income and Comprehensive Income Three
months ended March 31, 2004 and 2003 4
Consolidated Statements of Cash Flows
Three months ended March 31, 2004 and 2003 5
Notes to Consolidated Financial Statements 7
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3 Quantitative and Qualitative Disclosures About Market Risk 15
Item 4 Controls and Procedures 16
PART II OTHER INFORMATION
Item 1 Legal Proceedings 16
Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities 16
Item 3 Defaults Upon Senior Securities 17
Item 4 Submission of Matters to a Vote of Security Holders 17
Item 5 Other Information 17
Item 6 Exhibits and Reports on Form 8 - K 17
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FNB Financial Services Corporation and Subsidiary
Consolidated Balance Sheets
(Dollars in thousands except par value)
March 31, December 31,
2004 2003
(Unaudited) (Audited)
------------- -------------
ASSETS
Cash and due from banks $ 21,613 $ 29,319
Investment securities:
Securities available for sale 134,195 139,799
Federal Home Loan Bank and Federal Reserve Bank Stock 3,732 3,882
Loans 597,245 581,384
Allowance for credit losses (7,203) (7,124)
------------- -------------
Loans, net 590,042 574,260
------------- -------------
Premises and equipment, net 13,012 13,031
Accrued income and other assets 31,967 20,635
------------- -------------
Total assets $ 794,562 $ 780,926
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing $ 73,778 $ 69,982
Interest bearing 566,271 571,925
------------- -------------
Total deposits 640,049 641,907
Federal funds purchased and retail repurchase agreements 23,317 15,363
Other borrowings 57,500 55,500
Accrued expenses and other liabilities 5,266 2,406
------------- -------------
Total liabilities 726,131 715,176
------------- -------------
Shareholders' Equity:
Preferred stock no par value; authorized 10,000,000 shares;
none issued -- --
Common stock, $1.00 par value; authorized 40,000,000 shares;
outstanding 5,494,831 at March 31, 2004 and
5,478,664 at December 31, 2003 5,495 5,479
Paid-in capital 22,090 22,025
Retained earnings 39,908 38,395
Accumulated other comprehensive income 937 (149)
------------- -------------
Total shareholders' equity 68,430 65,750
------------- -------------
Total liabilities and shareholders' equity $ 794,562 $ 780,926
============= =============
See notes to unaudited consolidated financial statements.
3
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Income and Comprehensive Income
(Unaudited; dollars in thousands, except per share data)
Three Months Ended
March 31,
------------------------
2004 2003
---------- -----------
Interest income
Loans $ 9,187 $ 9,079
Federal funds sold and overnight deposits 17 14
Investment securities
Taxable 857 1,262
Tax exempt 329 147
Other 48 50
---------- -----------
Total interest income 10,438 10,552
---------- -----------
Interest expense
Deposits 3,168 4,117
Federal funds purchased and other borrowings 422 415
---------- -----------
Total interest expense 3,590 4,532
---------- -----------
Net interest income 6,848 6,020
Provision for credit losses 388 495
---------- -----------
Net interest income after provision for credit losses 6,460 5,525
Noninterest income
Service charges on deposit accounts 1,012 760
Net gain on securities available for sale 111 322
Net gain on disposition of other assets 122 10
Income from investment services 134 141
Mortgage banking fees 334 463
Other income 128 98
---------- -----------
Total noninterest income 1,842 1,794
Noninterest expense
Salaries and employee benefits 2,797 2,546
Occupancy expense 325 282
Furniture and equipment expense 670 531
Insurance expense, including FDIC assessment 50 48
Marketing expense 151 98
Printing and supply expense 131 118
Other expenses 1,322 989
---------- -----------
Total noninterest expense 5,446 4,612
Income before provision for income taxes 2,856 2,707
Provision for income taxes 961 957
---------- -----------
Net income 1,895 1,750
Other comprehensive income (loss) 1,086 (341)
---------- -----------
Comprehensive income $ 2,981 $ 1,409
========== ===========
Per share data
Net income, basic $ 0.35 $ 0.31
Net income, diluted $ 0.33 $ 0.30
Cash dividends $ 0.12 $ 0.11
Weighted average shares outstanding, basic 5,485,747 5,554,629
Weighted average shares outstanding, diluted 5,760,968 5,690,750
See notes to unaudited consolidated financial statements.
4
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited; dollars in thousands)
Three Months Ended
March 31,
---------------------
2004 2003
-------- --------
Cash flows from operating activities:
Interest received $ 1,899 $ 8,671
Fees and commissions received 889 1,920
Interest paid (3,558) (4,613)
Noninterest expense paid (1,875) (4,221)
Income taxes paid (469) (82)
Funding of loans held for sale (23,789) (22,480)
Proceeds from sales of loans held for sale 19,452 22,479
-------- --------
Net cash provided by (used in) operating activities (7,451) 1,674
-------- --------
Cash flows from investing activities:
Proceeds from sales or calls of securities available for sale 15,736 39,008
Purchase of securities (3,195) (34,866)
Capital expenditures (387) (1,811)
(Increase) decrease in other real estate owned (1,026) (312)
(Increase) decrease in loans (18,904) (11,527)
-------- --------
Net cash (used in) provided by investing activities (7,776) (9,508)
-------- --------
Cash flows from financing activities:
Increase (decrease) in demand, savings and interest
checking accounts 3,283 9,655
Increase (decrease) in time deposits (5,139) (7,739)
Increase (decrease) in federal funds purchased and
retail repurchase agreements 7,954 786
Increase (decrease) in other borrowings 2,000 --
Repurchase of common stock (320) (1,162)
Proceeds from issuance of common stock 400 327
Dividends paid (657) (620)
-------- --------
Net cash provided by (used in) financing activities 7,521 1,247
-------- --------
Net increase (decrease) in cash and cash equivalents (7,706) (6,587)
Cash and cash equivalents, January 1 29,319 24,524
-------- --------
Cash and cash equivalents, March 31 $ 21,613 $ 17,937
======== ========
Supplemental disclosure of non-cash transactions:
Non-cash transfers from loans to other real estate $ 1,197 $ 322
======== ========
See notes to unaudited consolidated financial statements.
5
FNB Financial Services Corporation and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited; dollars in thousands)
Reconciliation of net income to net cash provided by operating activities:
Three Months Ended
March 31,
---------------------
2004 2003
-------- --------
Net income $ 1,895 $ 1,750
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for credit losses 388 495
Depreciation 420 364
Accretion and amortization 253 135
(Gain) loss on sale of securities available for sale (111) (322)
(Gain) loss on sale of other assets (122) (10)
Funding of loans held for sale (23,789) (22,480)
Proceeds from sales of loans held for sale 19,452 22,479
(Increase) decrease in accrued income and other assets (18,196) 347
Increase (decrease) in accrued expenses and other liabilities 12,359 (1,084)
-------- --------
Net cash provided by operating activities $ (7,451) $ 1,674
======== ========
See notes to unaudited consolidated financial statements.
6
FNB Financial Services Corporation and Subsidiary
Notes to Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have
been prepared in accordance with generally accepted accounting principles
and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, these statements do not include all of the information and
footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation have been included. Operating results for the
three-month period ended March 31, 2004 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2004.
For further information refer to the consolidated financial statements and
footnotes thereto included in FNB Financial Services Corporation's 2003
Annual Report on Form 10-K. Certain reclassifications have been made to
the prior period consolidated financial statements to place them on a
comparable basis with the current period consolidated financial
statements.
2. Significant Activities
FNB Financial Services Corporation (the "Company") is a North
Carolina financial holding company. The Company's wholly owned subsidiary,
FNB Southeast (the "Bank"), is a North Carolina chartered commercial bank.
As of March 31, 2004, FNB Southeast operated thirteen banking
offices in North Carolina and five banking offices in Virginia. FNB
Southeast operates two wholly owned subsidiaries; FNB Southeast Investment
Services, Inc., which operated two offices, and FNB Southeast Mortgage
Corporation, which operated seven offices. The Company and the Bank are
headquartered in Reidsville, North Carolina. After May 1, 2004, the
Company's headquarters will be located in Greensboro, NC.
Effective April 16, 2004, The Bank of Tazewell purchased loans and
assumed the deposits of the Bank's Richlands branch. The Company
recognized $700,000 in net gain on the sale. Also during April, an
approximate $125,000 gain resulted from the sale of the fixed assets
associated with the Bank's Richlands branch.
3. Recent Accounting Pronouncements
In January 2003, the FASB issued FIN No. 46, "Consolidation of
Variable Interest Entities (an interpretation of Accounting Research
Bulletin No.51)." FIN No. 46, revised in December 2003, addresses the
consolidation by business enterprises of certain variable interest
entities. Management does not anticipate the implementation of this
interpretation to have a material impact on the Company's consolidated
financial statements.
4. Other Comprehensive Income
The Company's other comprehensive income for the three-month periods
ended March 31, 2004 and 2003 consists of unrealized gains and losses on
available for sale securities, net of related income taxes, as follows:
---------------------
2004 2003
-------- --------
Unrealized gains (losses) on available for sale securities $ 1,536 $ (238)
Reclassification adjustment for gains included in net income 111 322
-------- --------
Other comprehensive income (loss) before tax 1,647 (560)
Income tax expense (benefit) related to other comprehensive income 561 219
-------- --------
Other comprehensive income (loss) $ 1,086 $ (341)
======== ========
7
5. Stock-Based Compensation
The proforma impact on net income and net income per share as if the
fair value of stock-based compensation plans had been recorded as a
component of compensation expense in the consolidated financial statements
as of the date of grant of awards related to such plans, pursuant to the
provisions of SFAS No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure," which amends SFAS No. 123,
"Accounting for Stock Based Compensation,", is disclosed in the
accompanying table.
(Dollars in thousands, except per share data) 2004 2003
--------------------------------------------- -------- --------
Net income, as reported $ 1,895 $ 1,750
Less: Stock based compensation as calculated
per fair value method, net of tax effect (362) (174)
-------- --------
Proforma net income $ 1,533 $ 1,576
Earnings per share:
Basic - as reported $ 0.35 $ 0.31
Basic - proforma $ 0.33 $ 0.28
Diluted - as reported $ 0.33 $ 0.30
Diluted - proforma $ 0.32 $ .028
The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following
weighted average assumptions used in 2004 and 2003: dividend yield of
2.40% for 2004 and 2.75% for 2003; expected volatility of 16.0% for 2004
and 15.0% for 2003; risk free interest rates of 3.68% for 2004 and 3.75%
for 2003, and expected lives of seven years for all years.
These plans provide that shares granted come from the Company's
authorized but unissued common stock. The price of the options granted
pursuant to these plans will not be less than 100 percent of the fair
market value of the shares on the date of grant. The options granted in
1996 and thereafter vest ratably over a four-year period. No option will
be exercisable after ten years from the date granted.
6. Segment Information
Statement of Financial Accounting Standards ("SFAS") No. 131,
"Disclosure about Segments of an Enterprise and Related Information,"
establishes standards for determining an entity's operating segments and
the type and level of financial information to be disclosed in both annual
and interim financial statements. It also establishes standards for
related disclosures about products and services, geographic areas, and
major customers.
Operating segments are components of an enterprise with separate
financial information available for use by the chief operating decision
maker to allocate resources and to assess performance. The Company has
determined that it has one significant operating segment: the provision of
general financial services to the customers of its wholly owned
subsidiary, FNB Southeast. The various products offered by FNB Southeast
are those generally offered by community banks, and the allocation of
resources is based on the overall performance of the Company, rather than
the individual performance of banking offices or products.
8
7. Net Income Per Share
Basic and diluted earnings per share amounts have been computed
based upon net income as presented in the accompanying income statements
divided by the weighted average number of common shares outstanding or
assumed to be outstanding as summarized.
Three Months Ended
March 31,
----------------------
2004 2003
--------- ---------
Weighted average number of shares
used in basic EPS 5,485,747 5,554,629
Effect of dilutive stock options 275,221 131,121
--------- ---------
Weighted average number of common
shares and dilutive potential common
shares used in dilutive EPS 5,760,968 5,685,750
========= =========
As of March 31, 2004, there were 6,250 potentially dilutive share
options not included in the weighted average calculation since the option
exercise prices were greater than the average fair market value of the
common shares during the quarter.
8. Investment Securities
March 31, 2004 December 31, 2003
---------------------- ----------------------
(Dollars in thousands) Amortized Fair Amortized Fair
Cost Value Cost Value
--------- --------- --------- ---------
Available for sale:
U.S. Agency securities $ 81,002 $ 81,394 $ 88,534 $ 88,051
Mortgage backed securities 16,985 17,091 18,237 18,230
State and municipal obligations 33,477 34,493 32,617 32,850
Other 1,196 1,217 656 668
--------- --------- --------- ---------
Total available for sale 132,660 134,195 140,044 139,799
Federal Reserve Bank and Federal
Home Loan Bank stock 3,732 3,732 3,882 3,882
--------- --------- --------- ---------
Total investment securities $ 136,392 $ 137,927 $ 143,926 $ 143,681
========= ========= ========= =========
9. Loans (net of unearned income)
March 31, December 31,
(Dollars in thousands) 2004 2003
------------ ------------
Loan Category:
Real estate - commercial $ 149,616 $ 159,953
Real estate - residential 101,680 95,939
Real estate - construction 135,294 117,786
Commercial, financial and agricultural 92,198 90,224
Consumer 123,869 118,557
------------ ------------
Subtotal loans 602,657 582,459
Loans held for sale 5,412 1,075
------------ ------------
Gross loans $ 597,245 $ 581,384
============ ============
9
10. Allocation of Allowance for Credit Losses
March 31, 2004 December 31, 2003
--------------------------- ---------------------------
(Dollars in thousands) % of Loans in % of Loans in
Each Category Each Category
Allowance to Total Loans Allowance to Total Loans
--------- -------------- --------- --------------
Balance at end of period applicable to:
Real estate - construction $ 5 23 $ 5 20
Real estate - mortgage 37 41 49 44
Commercial 5,374 15 5,116 16
Consumer 1,787 21 1,954 20
------ ------ ------ ------
Total allocation $7,203 100% $7,124 100%
====== ====== ====== ======
11. Analysis of Allowance for Credit Losses
Three Months Ended
March 31,
--------------------------
(Dollars in thousands) 2004 2003
----------- -----------
Balance, beginning of period $ 7,124 $ 7,059
Charge-offs 327 520
Recoveries 18 142
----------- -----------
Net charge-offs 309 378
----------- -----------
Allowance charged to operations 388 495
----------- -----------
Balance, end of period $ 7,203 $ 7,176
=========== ===========
Ratio of annualized net charge-offs during the
period to average loans outstanding
during the period 0.21% 0.27%
=========== ===========
Ratio of allowance for credit losses to
month end loans 1.21% 1.25%
=========== ===========
Nonperforming Assets
March 31, December 31,
(Dollars in thousands) 2004 2003
----------- ------------
Nonaccrual (1) $ 3,502 $ 5,174
Past due 90 days or more and still accruing interest 53 53
Other real estate 5,019 5,191
(1) Other than amounts listed above, there are no other loans which: (a)
represent or result from trends or uncertainties which management
reasonably expects will materially affect future operating results,
liquidity, or capital resources, or (b) represent material credits about
which management is aware of any information which causes management to
have serious doubts as to the ability of such borrowers to comply with the
loan repayment terms.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Information set forth below may contain various forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, which statements represent the Company's
judgment concerning the future and are subject to risks and uncertainties that
could cause the Company's actual operating results to differ materially.
Forward-looking statements can be identified by the use of forward-looking
terminology, such as "may", "will", "expect", "anticipate", "estimate",
"believe", or "continue", or the negative thereof or other variations thereof or
comparable terminology. The Company cautions that forward-looking statements are
further qualified by important factors that could cause the Company's actual
operating results to differ materially from those in the forward-looking
statements. Forward-looking statements speak only as of the date made, and the
Company's management may not update them to reflect changes that occur after
that date.
Application of Critical Accounting Policies
The Company's accounting policies are fundamental to understanding
management's discussion and analysis of results of operations and financial
condition. The Company's significant accounting policies are discussed in detail
in Note 1 of the consolidated financial statements included in the Company's
2003 Annual Report on Form 10-K. The following is a summary of the allowance for
credit losses, one of the most complex and judgmental accounting policies of the
Company.
The allowance for credit losses, which is utilized to absorb actual losses
in the loan portfolio, is maintained at a level consistent with management's
best estimate of probable credit losses incurred as of the balance sheet date.
The Company's allowance for credit losses is also analyzed quarterly by
management. This analysis includes a methodology that separates the total loan
portfolio into homogeneous loan classifications for purposes of evaluating risk,
as well as analysis of certain individually identified loans. The required
allowance is calculated by applying a risk adjusted reserve requirement to the
dollar volume of loans within a homogenous group. Major loan portfolio subgroups
include: risk graded commercial loans, mortgage loans, home equity loans, retail
loans and retail credit lines. Management also analyzes the loan portfolio on an
ongoing basis to evaluate current risk levels, and risk grades are adjusted
accordingly. While management uses the best information to make evaluations,
future adjustments may be necessary, if economic or other conditions differ
substantially from the assumptions used.
Summary
Assets at March 31, 2004 were $794.6 million, an increase of $13.6 million
since December 31, 2003. The increase in assets resulted primarily from an
increase in loans of $15.9 million over the first three months of 2004. Deposits
at March 31, 2004 were $640.0 million, compared to $641.9 million at December
31, 2003.
Net income for the quarter ended March 31, 2004, of $1.9 million was
$145,000 or 8.3%, higher than the amount earned in the first quarter last year.
Diluted earnings per share for the current quarter was $0.33 per share, compared
to $0.30 per share a year ago.
Interest Income and Interest Expense
First quarter total interest income was $10.4 million, a decrease of 1.1%
over the same quarter last year. Average earning assets for the quarter were
$742.2 million, compared to $708.6 million for the year ago period. Interest
income from loans was $9.2 million, compared to $9.1 million in the first
quarter of 2003. The prime lending rate was 25 basis points lower during first
quarter 2004 than during first quarter 2003. Average loans for the first quarter
of 2003 were $590.1 million, $19.7 million, or 3.5%, higher than the $570.4
million last year. For the first quarter, the average yield on loans was 6.26%
in 2004 compared to 6.46% in 2003.
11
Interest income on investments totaled $1.3 million for the current
quarter, down 15.0% from $1.5 million for the year ago quarter. The change was
primarily attributable to a decrease of $398,000 in interest income on U.S.
Agency securities, combined with an increase of $176,000 in interest income on
municipal securities.
First quarter total interest expense was $3.6 million compared to $4.5
million from the first quarter of last year, a 20.8% decrease. Average interest
bearing liabilities for the first quarter 2004 increased 5.6% to $643.2 million
from $609.0 million for the first quarter of 2003. Overall cost of funds for the
first quarter was 2.02% and 2.74% for 2004 and 2003, respectively.
Interest expense on deposits for the first quarter 2003 was $3.2 million,
compared to $4.1 million in the same period a year ago. A 4.3% increase in
average interest bearing deposits, from $543.7 million in first quarter 2003 to
$566.8 million during first quarter 2004, offset by a decrease in the average
rate for the quarter on interest-bearing deposits to 2.25%, from 3.07% one year
earlier, yielded this decrease in interest expense on deposits.
Interest expense on federal funds purchased and other borrowings was
$422,000 for the current quarter, an increase of 1.6%, from $415,000 in the
first quarter of 2003. The increase was primarily attributable to an increase in
average federal funds purchased and other borrowings from $65.4 million in the
first quarter of 2003 to $76.4 million in the first quarter of 2004.
Comparable net interest margins are as follows:
Liability
Time Period Asset Yield Rate Interest Rate Spread
- ----------- --------------- ------------- ------------------------
First Quarter, 2004 5.75% - 2.02% = 3.73%
First Quarter, 2003 6.09% - 2.74% = 3.35%
Provision for Credit Losses
A provision for credit losses is charged against earnings in order to
maintain the allowance for credit losses at a level that reflects management'
evaluation of the incurred losses inherent in the portfolio. The amount of the
provision is based on continuing assessments of nonperforming and "watch list"
loans, analytical reviews of loan loss experience in relation to outstanding
loans, loan charge-offs, nonperforming asset trends and management's judgment
with respect to current and expected economic conditions and their impact on the
existing credit portfolio.
The provision for credit losses in the first quarter of 2004 was $388,000,
compared to $495,000 in 2003. The allowance for credit losses as a percentage of
gross loans outstanding was 1.21% at March 31, 2004, compared to 1.25% at March
31, 2003. At March 31, 2004 and 2003, the allowance, as a percentage of
nonaccrual loans, was 205.7% and 107.1%, respectively.
Noninterest Income and Noninterest Expense
Noninterest income in the first quarter this year increased $47,000, or
2.6%, over the same period last year. For the current quarter, $111,000 in net
gains from sales of investment securities was recognized, compared to $322,000
for the same quarter last year. A gain of $122,000 was recognized in the first
quarter of 2004 on the sale of SBA loans with a current guaranteed amount of
$2.2 million. Deposit service charges of $1.0 million for the first quarter of
2004 reflect a 33.2% increase from $760,000 in the first quarter of 2003.
Mortgage banking fees decreased $129,000, from $463,000 in the first quarter of
2003 to $334,000 in the current quarter and investment service fees in the first
quarter of 2003 were $134,000, compared to $141,000 for the same period last
year, a 5.2% decrease.
Noninterest expense for the first quarter of 2004 was $5.4 million, an
18.1% increase over the $4.6 million expense in the first quarter of 2003.
Salaries and employee benefits increased $251,000, based on higher insurance and
retirement costs, occupancy expense increased $43,000, and equipment
12
expense was $139,000 higher, compared to the same period a year ago. Other
expense increased $333,000 in the first quarter of 2004, compared to the first
quarter of 2003. Items contributing to this overall net increase were increases
in staff development expenses, marketing expense, telephone expense, loan
filing, credit report and appraisal fees, OREO expenses, franchise taxes,
contracted services, professional fees, postage, printing and supplies.
Income Taxes
The effective income tax rate for the first three months of 2004 was
33.7%, compared to 35.4% for the same period in 2003. The decline in the
effective rate from 2003 to 2004 reflects the implementation of investment
strategies that resulted in a reduction in the consolidated income tax
provision. The increase in the provision for 2004, compared to the prior year
period, results from higher pretax income, offset in part by a lower effective
tax rate. Overall, the effective tax rate is attributable to the current expense
required to provide an adequate provision for income taxes at March 31, 2004 and
2003.
ANALYSIS OF FINANCIAL CONDITION
The Company's total assets at March 31, 2004 and 2003 were $794.6 million
and $744.9 million, respectively, representing a $49.7 million, or 6.7%,
increase over the balance a year ago. Since December 31, 2003, assets have
increased $13.6 million. Average earning assets for the 2004 first quarter were
$742.2 million, or 4.7% higher than the $708.6 million average in the same
quarter last year.
Loans at March 31, 2003 totaled $597.2 million compared to $575.2 million
one year earlier, an increase of 3.8%. Loans have increased 2.7% from $581.4
million at December 31, 2003. Average loans for the first quarter of 2003 were
$590.1 million, or 3.5% higher than the $570.4 million average in this same
period one year ago.
Investment securities of $137.9 million at March 31, 2004 were 3.2% higher
than the $133.7 million held one year earlier. Average investment securities
were $145.0 million and $131.8 million for the first quarter of 2004 and 2003,
respectively.
Deposits totaled $640.0 million at March 31, 2004, compared to $641.9
million at December 31, 2003 and $606.9 million recorded at March 31, 2003.
Noninterest bearing deposits were $73.8 million, or 11.5% of total deposits at
March 31, 2004. Federal funds purchased, retail repurchase agreements, and other
borrowings totaled $80.8 million at March 31, 2004 and $70.9 million at December
31, 2003. The increase in borrowings funded increased amounts of loans.
Shareholders' equity was $68.4 million at March 31, 2004, compared to
$65.8 million at December 31, 2003. The Company paid dividends of $0.12 per
share during the current quarter, compared to $0.11 per share in the first
quarter of 2003.
Asset Quality
The credit loss allowance ratio at March 31, 2004 stood at 1.21% of gross
loans outstanding, compared to 1.23% at December 31, 2003 and 1.25% at March 31,
2003. For the first quarter of 2004, provision charges against earnings totaled
$388,000 compared to $495,000 in the first quarter one year earlier. Net credit
losses for the 2004 first quarter totaled $309,000, or a 0.21% annualized loss
ratio based on average loans outstanding. This compares to net credit losses of
$378,000, or 0.27% annualized loss ratio for the 2003 first quarter.
The Company's allowance for credit is analyzed quarterly by management.
This analysis includes a methodology that segments the loan portfolio by
selected types and considers the current status of the portfolio, historical
charge-off experience, current levels of delinquent, impaired and non-performing
loans, as well as economic and other risk factors. It is also subject to
regulatory examinations and determinations as to adequacy, which may take into
account such factors as the methodology
13
employed and other analytical measures in comparison to a group of peer banks.
Management believes the allowance for loan losses is sufficient to absorb known
risk in the portfolio. No assurances can be given that future economic
conditions will not adversely affect borrowers and result in increased losses.
Other real estate owned decreased to $5.0 million at March 31, 2004,
compared to $5.2 million at December 31, 2003. Approximately $1.2 million has
been transferred from loans into other real estate and approximately $1.4
million of such assets have been disposed of during the first quarter of 2004. A
net loss of $80,000 has been recorded on disposition of other real estate in the
current year.
Capital Resources
Banks and financial holding companies, as regulated institutions, must
meet required levels of capital. The Office of the Commissioner of Banks in
North Carolina and the Board of Governors of the Federal Reserve, which are the
primary regulatory agencies for FNB Southeast and the Company, respectively,
have adopted minimum capital regulations or guidelines that categorize
components and the level of risk associated with various types of assets.
Financial institutions are required to maintain a level of capital commensurate
with the risk profile assigned to their assets in accordance with the
guidelines.
As shown in the accompanying table, the Company and its wholly-owned
banking subsidiary have capital levels exceeding the minimum levels for "well
capitalized" banks and financial holding companies as of March 31, 2004.
Regulatory Guidelines
---------------------------------
Well Adequately FNB
Ratio Capitalized Capitalized Company Southeast
----- ---------------- -------------- ------------- -------------
Total Capital 10.0% 8.0% 11.76% 11.38%
Tier 1 Capital 6.0 4.0 10.61 10.23
Leverage Capital 5.0 4.0 8.46 8.16
Sarbanes-Oxley Act of 2002
On July 30, 2002, the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley
Act") was signed into law and became some of the most sweeping federal
legislation addressing accounting, corporate governance and disclosure issues.
The impact of the Sarbanes-Oxley Act is wide-ranging as it applies to all public
companies and imposes significant new requirements for public company governance
and disclosure requirements. Some of the provisions of the Sarbanes-Oxley Act
became effective immediately while others were implemented over the 18 months
following its passage.
In general, the Sarbanes-Oxley Act mandates important new corporate
governance and financial reporting requirements intended to enhance the accuracy
and transparency of public companies' reported financial results. It establishes
new responsibilities for corporate chief executive officers, chief financial
officers and audit committees in the financial reporting process and creates a
new regulatory body to oversee auditors of public companies. It backs these
requirements with new SEC enforcement tools, increases criminal penalties for
federal mail, wire and securities fraud, and creates new criminal penalties for
document and record destruction in connection with federal investigations. It
also increases the opportunity for more private litigation by lengthening the
statute of limitations for securities fraud claims and providing new federal
corporate whistleblower protection.
The economic and operational effects of this new legislation on public
companies, including the Company, will be significant in terms of the time,
resources, and costs associated with complying with the new law. Because the
Sarbanes-Oxley Act, for the most part, applies equally to public companies of
all sizes, the Company will be presented with additional challenges as a
smaller, community-oriented financial institution seeking to compete with larger
financial institutions in the Company's markets.
14
Liquidity Management
Liquidity management refers to the ability to meet day-to-day cash flow
requirements based primarily on activity in loan and deposit accounts of the
Company's customers. Deposit withdrawals, loan funding and general corporate
activity create a need for liquidity for the Company. Liquidity is derived from
sources such as deposit growth; maturity, calls, or sales of investment
securities; principal and interest payments on loans; access to borrowed funds
or lines of credit; and profits.
During the first quarter of 2004, the Company had net cash used in
operating activities of $7.5 million, compared to $1.7 million of net cash
provided by operating activities in the first quarter of 2003. The decline is
primarily attributable to the decline of $6.8 million in interest received and a
decrease in interest expense paid of $1.1 million.
Net cash used in investing activities in the 2004 first quarter totaled
$7.8 million, primarily based on the purchase of $3.2 million in investment
securities and an $18.9 million funding increase in gross loans, offset by the
proceeds from the sale of securities available for sale totaling $15.7 million.
This compares to the first quarter of 2003 when proceeds from the sale of
securities available for sale, totaling $39.0 million, combined with an increase
in gross loans outstanding of $11.5 million, resulted in net cash provided by
investing activities of $9.5 million.
Financing activities in the 2004 first quarter provided $7.5 million,
based primarily on a $10.0 million increase in federal funds purchased, retail
repurchase agreements and other borrowings, combined with a $1.9 million
decrease in deposits. During the 2003 first quarter, financing activities
provided $1.2 million.
Overall cash and cash equivalents totaled $21.6 million at March 31, 2004
compared to $29.3 million at December 31, 2003 and $17.9 million at March 31,
2003.
Liquidity is further enhanced by an approximately $130 million line of
credit with the Federal Home Loan Bank ("FHLB") collateralized by FHLB stock,
investment securities and qualifying 1 to 4 family residential mortgage loans.
The Company provides various reports to the FHLB on a regular basis throughout
the year to maintain the availability of the credit line. Each borrowing request
to the FHLB is initiated through an advance application that is subject to
approval by the FHLB before funds are advanced under the credit agreement.
The Company also has unsecured overnight borrowing lines totaling $19
million available through four financial institutions. These lines are used to
manage the day-to-day, short-term liquidity needs of the Company. Each Federal
funds line has a requirement to repay the line in full on a frequent basis,
typically within five to ten business days.
Effects of Inflation
Inflation affects financial institutions in ways that are different from
most commercial and industrial companies, which have significant investments in
fixed assets and inventories. The effect of inflation on interest rates can
materially impact bank operations, which rely on net interest margins as a major
source of earnings. Non-interest expenses, such as salaries and wages, occupancy
and equipment cost are also negatively impacted by inflation.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the possible chance of loss from unfavorable changes in
market prices and rates. These changes may result in a reduction of current and
future period net interest income, which is the favorable spread earned from the
excess of interest income on interest-earning assets, over interest expense on
interest-bearing liabilities.
15
The Company considers interest rate risk to be its most significant market
risk, which could potentially have the greatest impact on operating earnings.
The Company is asset sensitive, which means that falling interest rates could
result in a reduced amount of net interest income. The monitoring of interest
rate risk is part of the Company's overall asset/liability management process.
The primary oversight of asset/liability management rests with the Company's
Asset and Liability Committee. The Asset and Liability Committee meets on a
regular basis to review asset/liability activities and to monitor compliance
with established policies.
The Company has not experienced any substantive changes in portfolio risk
during the three months ended March 31, 2004.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
The Company's management, under the supervision and with the participation
of the Chief Executive Officer and the Chief Financial Officer of the Company
(its principal executive officer and principal financial officer, respectively),
has concluded based on its evaluation as of the end of the period covered by
this Report, that the Company's disclosure controls and procedures are effective
to ensure that information required to be disclosed by the Company in the
reports filed or submitted by it under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time periods
specified in the applicable rules and forms, and include controls and procedures
designed to ensure that information required to be disclosed by the Company in
such reports is accumulated and communicated to the Company 's management,
including the Chief Executive Officer and the Chief Financial Officer of the
Company, as appropriate to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting
There have been no significant changes in internal control over financial
reporting during the period covered by this Report that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
The accompanying table details, by month, the information related to the
activity related to the share repurchase program approved by the Company's Board
of Directors in November 2002 and publicly announced that same month. A total of
279,814 shares were approved for repurchase.
Stock Repurchase Program - Approved November 2002
-------------------------------------------------
(a) (b) (c) (d)
Maximum Number
Total Number of Average Price Cumulative Number of of Shares that May Yet Be
Period Shares Purchased Paid Per Share Shares Purchased Purchased
- --------------------------
January 1, 2004 to
January 31, 2004......... -- N/A 171,941 107,873
February 1, 2004 to
February 29, 2004........ 8,100 $20.39 180,041 99,773
March 1, 2004 to
March 31, 2004........... 7,500 $20.37 187,541 92,273
Total.......... 15,600 $20.38
16
Item 3 Defaults Upon Senior Securities
Not Applicable.
Item 4 Submission of Matters to a Vote of Security Holders
None.
Item 5 Other Information
None.
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
- ----------- -----------
3.01 (1) Amended and Restated Articles of Incorporation.
3.02 (1) Bylaws of Company, as amended.
4.01 (1) Specimen Common Stock Certificate.
10.01 (3) Stock Compensation Plan of the Registrant approved April 11,
1989, by the shareholders of the Registrant, with forms of stock
option and stock bonus agreements attached.
10.02 (4) Omnibus Equity Compensation Plan of the Registrant.
10.03 (5) Severance Policy for Senior Officers of the Registrant (employed
for five years or more).
10.04 (6) Revised Severance Plan for Senior Officers of the Registrant
(employed for five years or more).
10.05 (4) Severance Policy for Senior Officers of the Registrant (employed
for less than five years).
10.06 (8) Benefit Equivalency Plan of the Registrant effective January 1,
1994.
10.07 (12) Annual Management Incentive Plan of the Registrant.
10.08 (8) Long Term Incentive Plan of the Registrant.
10.09 (11) Long Term Incentive Plan of the Registrant for certain senior
management employees.
10.10 (8) Employment Agreement dated May 18, 1995, between the Registrant,
as employer, and Ernest J. Sewell, President and Chief Executive
Officer of the Registrant.
10.11 (9) Split-Dollar Agreement dated January 27, 1995, between the
Registrant and Ernest J. Sewell.
10.13 (9) Split-Dollar Agreement dated January 27, 1995, between the
Registrant and C. Melvin Gantt.
10.14 (9) Split-Dollar Agreement dated December 8, 1995, between the
Registrant and Richard L. Powell.
10.16 (2) Amendment to Benefit Equivalency Plan of the Registrant
effective January 1, 1998.
31.01 Certification of Ernest J. Sewell
31.02 Certification of Michael W. Shelton
32.01 Certification of Periodic Financial Report Pursuant to 18 USC
Section 1350.
17
Exhibit references:
(1) Incorporated herein by reference to the Registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended March 31, 1998,
filed with the Securities and Exchange Commission.
(2) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1998, filed with
the Securities and Exchange Commission.
(3) Incorporated herein by reference to the Registrant's Statement on
Form S-8 (No. 33-33186), filed with the Securities and Exchange
Commission.
(4) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1996, filed
with the Securities and Exchange Commission.
(5) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1989, filed with
the Securities and Exchange Commission.
(6) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1994, filed
with the Securities and Exchange Commission.
(7) Incorporated herein by reference to the Registrant's Quarterly
Report, on Form 10-QSB for the fiscal quarter ended June 30, 1995,
filed with the Securities and Exchange Commission.
(8) Incorporated herein by reference to the Registrant's Statement on
Form S-2 (File No. 333-47203) filed with the Securities and Exchange
Commission on March 3, 1998.
(9) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-KSB for the fiscal year ended December 31, 1997, filed
with the Securities and Exchange Commission.
(10) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2002, filed with
the Securities and Exchange Commission
(11) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1999, filed with
the Securities and Exchange Commission.
(12) Incorporated herein by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2003, filed with
the Securities and Exchange Commission.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K, dated March 15, 2004,
stating that on March 15, 2004 a notice had been filed with the SEC on Form
12b-25 to obtain a fifteen day extension of the deadline for filing its Annual
Report on Form 10-K for the period ended December 31, 2003.
The Company filed a Current Report on Form 8-K, dated April 22, 2004, to
report the results of operations for the first quarter of 2004.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FNB FINANCIAL SERVICES CORPORATION
(Registrant)
May 10, 2004 /s/ MICHAEL W. SHELTON
------------------------------------------------
Michael W. Shelton, Senior Vice President, Chief
Financial Officer, Secretary and Treasurer
19